Capital Budgeting Analysis for I-KNOWIT Technologies

This assignment analyzes the profitability of a proposed investment by I-KNOWIT Technologies in new equipment for producing RFID blocking pads. Various capital budgeting techniques, including Net Present Value (NPV), Internal Rate of Return (IRR), and Payback Period, are applied to evaluate the project's feasibility under different financing scenarios. The analysis considers factors like cash flows, depreciation, opportunity costs, and the cost of borrowing to determine whether the investment is financially viable for I-KNOWIT Technologies.

[Type the company name]
Capital Budgeting Analysis
I-KNOWIT Technologies

I-KNOWIT Technologies wants to invest 100 million in equipment which will help in
production of innovative RFID blocking pads for wireless credit card protection. The
company has estimated the various cash flows associated with the project and expects the
project to continue for 10 years due to the constantly changing technology.
A capital budgeting analysis was conducted to evaluate if the project is profitable and if the
company should undertake the investment. The capital budgeting techniques like NPV, IRR
and payback period were used in the analysis. Also the result of the analysis if the equipment
would be financed by loan was done and the results are discussed hereafter.
The various assumptions taken for the analysis are discussed below:
a) The working capital is recovered at the end of the period
b) The cost of feasibility study of $1,000,000 and the research and development costs of $15
million have not been taken into consideration as these are sunk costs and will not affect the
cash flows of the project.
c) The loss of rent has been considered as the opportunity cost and is taken to be tax
deductible.
d) The depreciation has been calculated on the straight line basis and the complete cost of
equipment has been depreciated over the period of 10 years.
e) The cost of borrowing of 25% has been considered to be fixed cost to be incurred every
year for 10 years and the loan amount is repaid at the end of 10 years.
On the basis of the above assumptions, a table of incremental cash flows was prepared (in the
annexure). The results of the various techniques of capital budgeting analysis are discussed
below:
a) Payback period
Year Net cash flow
Cumulative
cash flows
0 -$10,30,00,000 -$10,30,00,000
1 $1,56,00,000 -$8,74,00,000
2 $1,56,00,000 -$7,18,00,000
3 $1,56,00,000 -$5,62,00,000
4 $1,70,00,000 -$3,92,00,000
5 $1,85,40,000 -$2,06,60,000

6 $2,02,34,000 -$4,26,000
7 $2,20,97,400 $2,16,71,400
8 $1,79,97,920 $3,96,69,320
9 $1,47,18,336 $5,43,87,656
10 $1,85,94,669 $7,29,82,325
Payback period = 6 + (-426000/22097400)
= 6.02 years
b) NPV = $3,486,250
c) IRR = 11%
d) Based on the payback period, NPV and IRR, it is recommended to invest in the equipment.
If the NPV of a project is positive or more than 1 than the project should be accepted because
NPV is the excess of inflow over the outflow discounted by the cost of capital. If the cash
inflow is more than the outflow, than the project is profitable and hence it should be accepted.
NPV is the most important factor in deciding upon a project. If the NPV is negative and other
techniques are favourable for the project, than the project will never be accepted because the
cash outflows are more than cash inflows and the project will not be profitable. The payback
period of the project is 6 years which means the initial cash outflow of $100 million will be
recovered within 6 years. Since the investment in the project will be recovered in the lifetime
of the project, hence the project should be accepted. The IRR of the project is 11% which is
more than the cost of capital of 10%; hence the IRR is also favourable. The rule under capital
budgeting is that if the IRR of the project is more than the cost of capital, than the project
should be accepted.
So we see that all the capital budgeting techniques including NPV, Payback period and IRR
are favourable, hence it is recommended that I-KNOWIT Technologies should go ahead with
the investment of $100 million in the new equipment.
e) If the company were to finance the project from the borrowings, the company would have
to take a loan of $100 million (cost of equipment). The loan is available at a cost of 25% p.a.
The borrowing will have two effects on the incremental cash flows. The initial investment
will decrease by $100 million as there is cash inflow of loan amount. However, the interest

on loan of 25% will be an operating expense and will be tax deductible. Also the loan of $100
million will be repaid at the end of the project in the 10th year.
As a result of the above, the NPV (calculation in annexure) of the project has become NPV
making the project non feasible. Negative NPV means that the cash outflows are more than
the cash inflows; hence the project is not profitable. So if the investment is to be financed by
a loan with borrowing costs of 25%, the company should not go ahead with the project.